IRVINE, CA-Real estate investment banker Moss Adams Capital has a big-picture view of the commercial real estate industry from a variety of perspectives. GlobeSt.com caught up with managing director Steve Duffy exclusively to discuss value-add investments and secondary markets, as well as where we are in the cycle.

GlobeSt.com: Have we reached the point in the cycle where investing is going beyond the primary markets?

Steve Duffy: You bet. We are long past core investing in multifamily, which started things, and now office, retail and industrial are breaking into the club. For multifamily, secondary markets are the most active targets for institutional investors on a broad basis right now. That includes secondary submarkets of primary markets, such as the Long Beach, North Orange County and western Riverside County around greater Los Angeles, as well as regional secondary markets such as Phoenix and Salt Lake City.

Retail has gradually shifted from core to secondary markets, and office not so much so far, except for a continuation of acquisitions with significant discounts from replacement cost that can generate high value-add and opportunistic returns. This behavior is totally consistent with the cycle. As the best markets get the initial investing action, they get expensive first. This drives a shift to improving secondary markets that can offer a yield premium. The yield premium for the risk is compressing most notably in multifamily, the champion product type of the current recovery.

GlobeSt.com: Why do you call this a "roll up your sleeves" phase of the cycle for capturing yield?

Duffy: There are three major ways to profit in commercial real estate: the going-in cap rate, the exit cap rate and the NOI improvement during the operating period. Our yield-thirsty planet has generally priced real estate assets to perfection on a relative basis. There is an underwriting consensus that compressing cap rates at the exit is unrealistic for five-year periods and beyond. This leaves the operating period as the place for profit and wealth creation.

This part of the asset plan is where the operating partners' execution means everything. The local market operators really earn their promote during this period. They have to find an asset opportunity in markets where everyone is looking. Local submarket-level knowledge and long-term relationships mean a great deal when competing with "out-of-towners" who are flush with capital. Operators have to identify where capital improvements can lead to real increases in revenues. They have to identify the improvements in the rent rolls and in the turnover process to get it done. They have to time all of this carefully for the best results in an environment where construction costs are rising. It is complex and requires skills in many functional areas: acquisitions, asset planning, construction management, leasing and project management.

This is far more challenging than taking a risk on a discounted purchase of a quality asset during the teeth of a recession and selling at a compressed cap rate in a rising market. We all have utmost respect for those "special forces" investors who, during dark times, worked successfully to get the capital to pull the trigger. Today, however, is different in many ways. Success during the hold period is the home-field advantage of the operator. Accordingly, leading investors get the idea to find and lock up talented local real estate operating companies as a way to allocate capital and profit during the next five years of this cycle.

GlobeSt.com: What's an example of a "roll up your sleeves" operator?

Duffy: It is easy to understand the value of the operator in retail real estate. Take neighborhood and community shopping centers. Food and drug centers in good locations have been bid up to core levels. The challenge is to find a center with some credit in the existing rent roll and credit potential in the revamped shopping center. This can take the form of a sub-performing or broken center that requires all sorts of improvements. It can be located in both forms of secondary markets. The asset plan could include re-parcelization to create pads in the underutilized parking lot and/or break up the flow of the shops. Struggling current tenants with near-term lease expirations can be negotiated or termed out. Capital expenditures focused beyond deferred maintenance to attract better-credit successor tenants can be programmed and physically executed at the same time of leasing activity, which actually could have started before acquisition close, and continues into new leasing. On the leasing front, operator relationships with non-Internet-exposed credit tenants are a huge and mandatory competency of a retail real estate operator. Without a cap-rate play, operator skills are critical to successful investing in a recovering and expanding economy. It sure looks like this is where we will be for the next couple of years.